The Crisis Explained

A very nice analogy, found here:

[quote]Analogies are never perfect, but here's one using horse racing. Don't expect a perfect correspondence to the banking situation, but I think it is close enough for government work.

Joe goes to the track and bets $2 on a horse.

Two guys standing nearby get into a discussion and Fred says to Sam, "I'll bet you $5 that Joe wins his bet."

Next to them are Bill and Bob. Bill says: "I'll bet you $10 that Fred welshes on his bet if he loses."

Next to them is Sally. Sally says: "For $3 I'll guarantee to Bill that if Bob fails to pay off, I'll make good on the bet."

Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn't expect to ever have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.

A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.

Question how much has been "invested" in the horse race?


$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.

The issue with the home market is that the only "investor" was the person who bought the home. All those engaged in the meaningless derivatives spun off from this are gambling. You can see how quickly the face value of all these side bets can exceed the underlying investment. Who is holding these side bets? Not the homeowner. It is the people at the failing investment banks, hedge funds and similar enterprises. Notice that the bailout is being directed at them not the homeowners.

The real world is, of course, even more complicated. Over the last 30 years people have been allowed to place bets on everything starting with the value of stock averages. They might as well bet on the temperature in Newark at 8:00 AM.

So when you hear everybody saying this is a crisis caused by the housing collapse, be skeptical. We are in the midst of a classic pyramid or Ponzi scheme and there is no way out except for people to lose a lot of money. All that is different this time is that it is the taxpayers who are being asked for the cash. [/quote]

This is a companion discussion topic for the original entry at

great analogy! I know understand just that little bit more how and why the economy is in such a dire strait, leaving out the underlying fact that it has a debt-based monetary system.

cheers again Chris its 7:45pm here in Australia and Im reloading your page to check for updates every hour! haha really appreciate your work.

Chris, your analogy is right on the money (no pun intended). How interesting that it came from the UK! The underlying issues at hand with the crisis in the system, and the bailout plans being implemented, are soley for the purpose of making more for the banks, and getting it from the population. To think that the beltway boys aren’t being manipulated in this grand scheme would just be naive. The country is NOT run by our electorate. It is, and it has been since 1913, run by a very short list of banking families. The plans have been in place for a very long time, and they seem to be right on track.


The doctor does it again. Only Chris could explain the entire ponzi scheme within 30 seconds in the most simplistic manner. Sadly such explanations are not available by the media for mass consumption. My experiences have indicated very few folks have a clue what this bailout is all about. One thing is certain. There is ZERO support.

Again …well done Doc


The price of gasoline is mysteriously low (just before the election) even though there are shortages.
Congress has just now happily given away a trillion dollars of phony money to fund a non-solution for a non-problem. As Chris noted in the post, we’re just paying off the wealthy’ gambling debts. It is better that one million middle-classers are foreclosed than for one billionaire to be reduced (the horror!) to a mere millionaire.
The congressional solution is VERY unpopular with the public.
It looks like the Republicans are going to lose the White House.
So, what are the chances that after the election:

  1. gasoline gets even more expensive than before (real soon)
  2. the media suddenly starts hammering on thie price of gasoline (much more than before)
  3. the Repubs and the media blame the Dems for wasting a trillion dollars on a non-problem, somehow (speculation?) causing the price of gasoline to shoot up.
  4. Bankers are happy
  5. Oil companies are happy
  6. Repubs can act like heros, insuring a return to power
  7. The public is dumbfounded and screwed
    Note that a trillion dollars with minimal oversight can provide a LOT of political grease.

and also a great analogy, very nice find :slight_smile:

I think there is a bit more to this - the person who borrowed funds to buy the horse got a loan with 1% interest for 6mo (the race is in 5mo) that will reset to 8% after that time. He must sell it after the race or he won’t be able to make the payments. The horse has a weak leg and is only worth 25k at most. The bank that made the loan to the owner sold the debt to a third party who then counted the 50k + interest (@8%) as an asset and borrowed $1.5 million against it to invest in (or bet on) other horse races. The party that loaned the 1.5 mil then counted that as an asset and… etc. etc. Others sold insurance against any party in the chain defaulting.

Isn’t that correct?

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I added a bit to complete the thought.

I think there is a bit more to this - the person who borrowed funds to buy the horse got a loan with 1% interest for 6mo (the race is in 5mo) that will reset to 8% after that time. He must sell it after the race or he won’t be able to make the payments. The horse has a weak leg and is only worth 25k at most. The bank that made the loan to the owner sold the debt to a third party who then counted the 50k + interest (@8%) as an asset and borrowed $1.5 million against it to invest in (or bet on) other horse races. The party that loaned the $1.5 mil then counted that as an asset and… etc. etc. Others sold insurance against any party in the chain defaulting and will have to pay out millions if the owner of the $25k horse defaults on his $50k loan.

The bailout plan intends to buy the $50k debt for $50k and thus prop up the pyramid of debt based on that loan, but as the horse is only worth $25k there will be a loss of at least $25k for the government. However, lots of other folks also bought over-priced horses and their loans haven’t yet reset - they will also be in default in a few months and more funds will be needed to keep the pyramid intact. Additionally, the government doesn’t have the $50k to loan and must borrow the funds from investors who made bets on the horse race and are angry that they weren’t told that the horse had a bad leg. Proposed rules changes will allow banks to value horses with bad legs at $50k when figuring assets used to back loans and borrowing - yet horses with bad legs can never be sold for $50k, so the banks position will remain unchanged and they will fail if they need to come up with cash (everyone now knows the horses have bad legs).

I appeciated the analogy, and the further analogy by CB.

However, gambling is a zero-sum game. For each loser there is a winner. The sum of the face value of all derivative products, CDS, and so on is huge, but the gamblers are more or less the same (hedge funds, banks, billionaires…). So, if Bear Sterns, Lehman, AIG, WaMu, Wachovia, etc. are the losers, who are the winners?

As regards mortgages, the winners are clearly the houseowners, who took the money and did not repay it to the lender (and the former owners who sold the house and got the money…), but for the huge derivative market built over the mortgage market, who are the winners? Where is the money?



In the original analogy, Sally, Bill, and/or Mary are the potential losers. If Bob does not make good on his bet if he loses, Sally will be on the hook to pay Bill the $10 and will still owe Mary the $8. One of the parties is going to have to take an $8 loss - either Sally, if she pays Mary back, Mary, if Sally defaults, or Bill, if Sally decides to pay Mary back her $8, and only gives Bill $2. I suppose that it could be that each party takes a partial loss, but the total loss will still be $8.


I hope that this helps,


I think it might be easier to see this analogy as "losing or gaining" LESS as opposed to who won or lost (absolute terms). If we see this in terms as winning and losing then we fail to make a sufficient analogy to the "imaginary" money. If there is a lot of "imaginary" money out there being gambled with then we cannot physically take or give tangible currency to/from the winner/loser and therefore would not "win or lose" anything except our spirits in the game. By me, having a home, may have lost LESS than the person who lost millions by gambling upon my investment. No one "won" the bet but I have lost less "x" in terms of the totality of the economic system we play the game in… just an idea kicking around in my head…


So if the first $50,000 was borrowed on a 0 down loan, how much was invested in the house and who invested it?


We are hearing that we have a liquidity problem. It seems to me that:
  1. This is a distraction. It is being created by the entities that have the problem, not by the people that don't have a problem.
  2. The real issue is price. There is always a price at which an asset can be sold to another entity. That price may even be negative, meaning that additional terms are required to divest the asset.
  3. We need to be careful not to listen and adopt the language that their price problem is our liquidity problem. This will cloud your thinking and not allow you to think clearly about our situation. All 'liquidity' problems can be converted to pricing:
  • The price of money.
  • The price of labor.
  • The price of debt.
  • The price of assets.
  • The price for a politician to remain in office.

Would you comment?

Dr. Martenson, thanks for your service info scout!! You have helped educate me on this peak oil phenom and its ramifications. Is it just me or have I correctly identified a significant shift/change about your site?

The site seems to have gone from the brevity/clarity and content sophistication of a "google" to the clouding/verbose, "anything goes" of say, "" or "CNBC". Perhaps some editorial moderation may be in order. Cool




There really has not been a change in content on the site that I could detect. Could you site some specific examples to support your argument? Chris provides very valuable information. Articles like this analogy and the videos in the crash course are designed to sort through the technical jargon and present the relavant facts in a clear, concise manner to the reader. None of the articles on here have been very verbose, and I would argue most have been written with clarity for the average Joe. A few trail off into technical terms, but are still well written.



Because in real life they are all drawing a fat wage off the profits they are "going" to make, and the racetrack authority takes a % fee on every bet placed ( regardless of the outcome ). All that money has been spent on champaign and caviar


the Bird & Fortune on the Subprime Mess.


but we all need it. It is up to a reader to select the right one that works for him/her. This example/analogy was really good. I am good at math…so I just started to gather ideas how to answer the question, but I newer really questioned the question. I think the biggest moral here is that you have to question the question. Analogy may can be interpreted as a derivative too, that rely on a person experience. So it must be different for you and for me. Some will work for you some not.

Another analogy to describe credit swap is this:

It is like changing your underwear…
Exchanging With your coworker.

Shocking, but why a person with a right mind is willing to change his used car (that has problems that he is aware) to exchange it with the coworkers used car that has problems that are not known to him. Because not knowing the problem makes you able to believe for a little while that there is no problem at all.


It would be you and me. We both living in an extremelly high strange world. We dont have to know how to kill a chicken to eat.